Why Trading In Your Gas Guzzler May Not Make Sense

Every time high gas prices are in the news, reporters inevitably find stories of people who are aghast at the prospect of paying $75 or $100+ to fill up the tank of their SUV or pickup every few days and want to trade their expensive, comfortable SUV in on a compact fuel miser that’s half the size with double the fuel economy. While this may may make economic sense when you run the numbers in some situations, many of the anecdotes cited in the popular media are not financially prudent at all. My service to you is to point out one obvious truth: you can buy a heck of a lot of gas for $5,000, even at $4.00 per gallon.

Of course, high fuel prices pinch everyone, but folks who bought large, thirsty vehicles for image or convenience reasons rather than out of necessity for their family or business needs are mainly the ones who complain the loudest about how they want to trade in their Armada on something smaller. Of course, there is much more to the cost of owning and operating a vehicle than just fuel costs. Monthly payments, sales tax (in some states) maintenance, repairs, registration, and depreciation are other big-ticket items that car owners have to contend with. Paying attention to only fuel costs is doing yourself a disservice.

Let’s take a few hypothetical examples of when it would and would not be cost-effective to trade down to a smaller vehicle. For the sake of simplicity, I’ll even ignore registration, sales tax, maintenance, and repairs and focus solely on the purchase price, depreciation, and fuel costs for 15,000 miles at $4.00 per gallon based on the EPA-estimated combined fuel economy using the downward-adjusted 2008-equivalent figures.

For example, let’s assume that someone bought a 2007 Chevy Trailblazer LS 4×4 a year ago for $28,000. According to Edmunds, this truck is worth about $16,000 today, one year into a five year loan. Assuming that the buyer put 20% down ($5,600), the original loan balance was $22,400 and the current loan balance is $18,347 (assuming 60 months @ 4.9%). Assuming that the Trailblazer got the EPA-estimated combined mileage of 16 mpg, at $4.00 per gallon and 15,000 miles per year, the annual fuel cost would be $3,750. Over five years, fuel would cost $18,750.

Then let’s say the person wants to buy a new Chevy Malibu LS four cylinder for $20,000 and puts 20% ($4,000) down and finance the $12,000 balance. With the same fuel price and miles-per-year assumptions, and at its EPA-estimated combined mileage of 25 mpg, the Malibu’s annual fuel cost is $2,400. Over five years, fuel would cost $12,000.

So, forgetting the purchase prices for a moment, the fuel cost difference is $6,750 over five years and $1,350 annually. That is $112.50 per month.

Now, we can’t forget that to make up for the Trailblazer’s $2,400 in negative equity (trading in the Trailblazer just one year into a five year loan) plus the 20% ($4,000) down for the Malibu means that you’ll be shelling out about $6,400 in cash to get out of the 2007 Trailblazer and into the 2008 Malibu, and that’s assuming that you move into a lightly-optioned Malibu. If you want more comfort/luxury features, you’ll have to step up to a Malibu LT, and that means more cash out. In fact, over five years, the cash difference is negligible. You’re also sacrificing the additional space and power that the Trailblazer could provide over the Malibu, not to mention the Trailblazer’s superior all-weather capabilities.

Of course, after the five years have passed, the more efficient Malibu will have broken even cost-wise, but until the five year point, the Trailblazer’s additional gasoline expenditures would roughly equal the cost to purchase the new Malibu.

There are other caveats associated the above example. Buying a used 2007 Malibu to replace the 2007 Trailblazer instead of a new 2008 model would make the cash outflow to purchase the more efficient vehicle much less. Also, replacing a guzzler with a more efficient car later in the guzzler’s loan (not after just one year) would eliminate the negative equity. Of course, if gas prices go beyond $4.00 per gallon, the more efficient vehicle gets more attractive financially. Lastly, replacing a paid-off inefficient vehicle that was about to be replaced anyway with a more efficient one is a prudent financial choice, as well as a more earth- and resource-friendly one.

The bottom line is that buyers are doing themselves a disservice if they do not do some simple arithmetic before spending thousands of dollars to “save” money that may – or may not – actually result in money savings. Even if buyers do the economic analysis, there will still probably be many folks who decide that gas prices are going nowhere but up, and who are tired of the steady drip-drip of money for fuel coming from their wallets, so they take a financial hit to get out of the guzzler and into something more “politically correct.”

Chris is Autosavant's Managing Editor. He has a lifelong love of everything automotive, having grown up as the son of a car dealer. A married father of two sons, Chris is also in the process of indoctrinating them into the world of cars and trucks.

6 Comments

r tynan

May 12, 2008

I have a lease so none of this matters. The lessor is going to take in in the shorts on the SUV that I’m turning in in two months because the residual they projected on the thing three years ago has collapsed. Not my problem on a lease.

I am going to lease the most fuel-efficient car I can without sacrificing too many luxury items. It’s got to get at least 30 mpg on the highway. It might be the smallest car I’ll have ever driven regularly.

David Surace

May 12, 2008

I think this illustrates the case that you very much have to put your money where your mouth is if you plan to do the “green” thing.

As always, lip-service is not an approved method of payment.

Anonymous

May 12, 2008

What if you keep a car for as long as seven years? And then gas costs 7 bucks a gallon seven years from now in 2015? Not that far-fetched, I think. The numbers change a lot in terms of whether it’s worth it.

skeeter tader

May 12, 2008

I have no idea what the difference is in terms of insurance, but it must be different for a $50,000 SUV compared to a Ford Focus, 4-cylinder Chevrolet Malibu, Honda Fit, Toyota Matrix, that cost $20,000 or less, etc. I imagine the annual difference is substantial.

Dennis Haak

May 12, 2008

All of the comments have been correct…a lease will certainly change the math. As long as you’re not paying a large penalty to get out of your lease (or it’s ended), then by all means jump into something more frugal.

Keeping a car for seven years, or trading in a car that’s paid off, definitely changes the math as well. The editorial was mainly focused on folks who freak out at high gas prices and lose their shirts on first-year depreciation just to pay less for gas.

Great point, skeeter tader, about the insurance as well, although a lot depends on the specific model. For example, my son’s 2004 Accord (worth about $10k) costs more to insure than his new 2008 Sienna (worth about $35k). That’s probably because minivans have both better accident survivability and are also involved statistically in fewer accidents.

George S

May 13, 2008

Most negative net equity in consumer goods is a result of consumers purchasing depreciating goods with an insufficient cash expenditure at the initial time of purchase to offset the immediate depreciation of the good. So if the purchaser is immediately in significant net equity with relation to the FMV of the good any significant change in operating costs or reduction of net income flow to the consumer will certainly exacerbate the perceived reduction in value to the consumer.

20% is not enough of an initial capital contribution to a good that depreciates by 20% in the first 12 months of ownership. That amount results in a car loan which is almost certainly upside down from Day 1!! The rule of thumb is that the total auto purchase price financed should never exceed 1/5 of one year’s net income. That is unless you prefer to live in your car.

Unfortunately, to lure customers into new car showrooms, loans are being backed often by the manufacturers to move inventory to borrowers spending 50% of their annual gross income on an automobile loan or lease payment.

Never before in American history have consumers stooped to borrow equity against typically appreciating assets, such as their homes, to buy depreciating good, such as cars. Not even during the Great Depression. This has become a recipe for a higher default rate on home mortgage loans.

So its not just on SUV purchases that motorists have negative equity. It’s probably on 90% of American private vehicle purchases.

If the average American earns $40K per year, deducting income tax, $30K remains. Modest housing runs $1000 per month, including utilities, RE taxes and insurances.Health insurances – another $300 per month. Food and clothing another $500 per month. Car loan payment $300 per month. (Assuming 20% down at 4% interest for 60 mo on a $20K car). Those expenses consume $25,200 of the remaining income. How can anyone claim that a $5000 a year (for now) gasoline allowance which will leave the $5000 net disposable income isn’t going to have a significant deleterious economic impact on the average American?